30 Jan 2015
Commissioned by the EVCA, Unquote’s study into the relationship between public funding bodies, institutional investors and fund managers comes at an important time for European venture capital; with a handful of billion-euro companies under their belts, the track-record of continental VCs is becoming increasingly attractive to investors.
Yet public funding body commitments continue to play a crucial role in the ecosystem, with public and private capital sources required to co-exist in harmony. This relationship is delicate but essential for the survival of European venture.
The catalytic role of public funding bodies should not be underestimated, acting as an encouraging seal of approval for potential investors of a fund’s investment strategy and proof of the successful completion of a disciplined due diligence process. According to a German fund manager included in the study: “We would not have got a large Japanese pension fund in if the [German government agency] KfW had not been there. It showed that everything was above board and adhering to regulations and professional standards.” For international investors making their first foray into European venture, the existing presence of a public funding body among the LP base can provide great reassurance.
The role is particularly important for first-time fundraisers, several of which have hit the fundraising road in recent years. Today, many of the first wave of European entrepreneurs are returning to the ecosystem on the other side of the table – as investors. They may not have a track-record of direct investment necessary to attract institutional limited partners (LPs), but they have successfully grown their start-ups through from inception to sale. Public commitments can help this transition.
Indeed, this public-private symbiosis is the basis of Invest Europe’s fund-of-funds proposal, which calls for a public-private partnership to attract private sector commitments and create a marketplace for investment into Europe’s strongest fund managers. Cornerstoned by the EU budget, which would have its commitment matched by private sources, the privately managed, pan-European programme aims to broaden the narrow pool of capital available to European venture fund managers. At a time when political emphasis to rebuild shaken economies has been firmly placed on SMEs, such a public-private partnership would catalyse private sector investment and expand the LP base available to European VCs.
Though the relationship between public and private is critical, it can also be testing. European fund managers recognise the fundamental role public funding bodies play in helping vehicles reach critical mass, but a third of respondents in the Unquote study highlighted restrictions on investment strategy and the drain on management time brought about by burdensome bureaucracy as the greatest drawbacks of public support. If this relationship is to evolve to meet future challenges, the bureaucratic burden must be relieved, leaving fund managers more time to source and execute investments and exits and, ultimately, return money to LPs.
As the European industry association, Invest Europe has a role to play in communicating the strengths of the continental ecosystem to potential investors. Segmented by sector and country, this data could help to raise awareness of rising returns across Europe. Such a database is particularly important given the predicament many VCs face when approaching institutional sources of capital, many of which do not have specific venture teams, being too large to dedicate resources to a relatively small allocation. Bringing together data from other industry associations across the continent, Invest Europe’s current database project will provide a framework for improving the robustness of returns data, ultimately helping LPs to make more informed allocation decisions.
And now is the time to get in on the action. Returns are improving, with home-grown headline-grabbers such as Criteo and Just Eat sat in Europe’s hall of fame alongside quieter home-runs such as Neolane. Though the window appears to be closing, the volume of successful listings last year is testament to the increasing maturity of European venture, and onlookers are taking note. According to one funding body cited in the study: “For the period 2000-2007, the returns were poorer than anticipated. For the period 2008-today, they have been better than anticipated. In the first part of the millennium, the quality of investments that were available to make and that we made were not as high as the quality since the crisis started.” Darwinism has been at work in the European ecosystem, as echoed in the finding that LPs find the quality of VCs in today’s market to be of higher quality than five years ago.
Of course, returns in Silicon Valley have often been stronger, but the ecosystem is more mature. And if the European ecosystem is to match the maturity of its older counterpart, we need investors – such as public funding bodies – that are ready to make a long-term commitment. “Public money is patient capital – capital that is less emotional,” said one Swiss family office. “In Europe we have a shorter track record and in order to build the industry we need to develop those track records. So in terms of keeping the industry alive the public money is very important. Hopefully at some point we will have a population of institutionally backable VC players that have stayed the course and proved themselves over the longer term, but they need the support of this patient capital.”
We were pleased with the introduction of the European Venture Capital Funds Regulation (EuVECA), which allows venture capital fund managers to market across borders in Europe via a passport scheme. Introduced by the European Commission last year following the adoption of the AIFM Directive, the regulation provides greater flexibility for smaller managers. We are supportive of any other mechanism the Commission can introduce to improve the single market for venture investments, levelling the playing field across the continent. We are hopeful that Solvency II and the Pension Funds Directive will be tailored to suit the asset class, and that the Commission remains aware of its importance in protecting the flow of investment capital into venture capital and, therefore, into European SMEs.
From regulation to mechanisms to expand sources of capital, creases are still being ironed out in Europe’s unfolding venture story, and public funding bodies provide essential support while this happens. But if institutional investors are to return to the asset class, providing a level of commitment in line with that enjoyed in the Valley, returns must remain on an upward trajectory. The trend has begun and hopefully will continue to climb.
Anne Glover, Chair for 2014-2015, EVCA
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